Jan 2024
As mentioned in the last monthly, the trends from 2023 continued into January 2024 driven by large caps and beta plays. However, unlike 2023, it looked to be much more Japan-specific. S&P 500 was up only +1.6%, MSCI Kokusai (World ex Japan, similar to MSCI EAFE for US investors) only +1.3%. The large cap tilt looks to be the same globally with the Russell 2000 down -3.9% and small caps underperforming large caps in most MSCI indices.
The drive came almost entirely from foreigners who net purchased +2.1 trillion yen of stock in January. To put that in perspective, they net bought +3.5 trillion during all of 2023 (and 2023 was not just foreigners; domestic industries [i.e. buybacks less cross shareholding unwind] bought +4.8 trillion throughout last year though they were less active in January 2024 with just +0.4 trillion). The Nikkei 225 was up +8.4% in Jan, closing at 36,286.71, the second largest move since 2020 (the first being last November) and just a stone’s throw away from the real estate bubble high of 38,957.44 reached on Dec 29, 1989. If the JPX didn’t say otherwise regarding flows, my old training would have shouted “government window-dressing!” given all of the political scandals by the current administration … yes, Japan was pretty backward, even as recently as the early 2000s and our stock market used to be, like China is today, “encouraged” by the government. But we know that is no longer true (or at least not across the market as a whole). While we don’t have information on what countries are driving the enthusiasm in Japan, I read in non-financial news outlets that the Chinese are dumping their home market for Japan. I have no idea, nor do I care all that much. But, it’s always good to be aware of what other people are thinking.
Most corporate earnings results start in Feb but a handful start during the last week in Jan. I’d note that the broader Topix (which was up +7.8 for the month) was down for the last week of the month so I think it safe to presume that it wasn’t positive earnings that drove the market. There were around 560 companies that announced from Jan 22 onward. The median post-earnings 1-day stock return was -0.4% and the 1-week stock return was -0.7% (the trimmed average excluding +/-5% outliers was +0.2% and -0.2% respectively). However, these 560+ contains quite a few microcaps so just focusing on companies whose market cap was over 1 trillion yen, this changes the results to +0.5%/+1.4% for the median and +0.1%/+0.9% for the trimmed average. Looking at some of the more significant ones, Canon announced weak results but announced a new share buyback program and mentioned ROEs for the first time; the stock was up +7.9% on the day of announcement but was flat for the rest of the week. Komatsu came in with firm Q3 results due to price hikes, but volumes were softer than expected. The company left guidance unchanged but taking into account the weaker yen, will likely be inline consensus (who is looking for flat to down OP next year); the stock was up +8.6% and followed up to +10.0% by the week. Stripping these two out (which, coincidentally, are both also major weak-yen beneficiaries), the average for large caps actually underperformed that of the 560-total for the day of earnings but still outperforms after a week. It tells me that the individual stock returns are still being driven less by fundamentals and more by flows and trends.
As for February, while I haven’t done a detailed analysis across the market (we still have another few days before all earnings are out), my gut tells me that it’s been fairly neutral (excluding currency tailwinds) ex autos. Toyota was a huge driver of the overall market sentiment last week after their surprisingly strong results driven by strong volumes and product mix, especially with hybrids in the North American market. While consensus agrees that all-time high margins are unsustainable due to several positive factors that all collided this past quarter, their hybrid strategy could help maintain strong profitability. Toyota is a major fundamental (and stock) driver of the entire Japanese market, probably the biggest for a single company. Strong growth will help sustain Japan (which, in Toyota’s case, is significantly dependent on the US consumer). But, despite the surprise Q3 results (and the stock performance since), the market is widely expecting growth to notably slow next year and, Toyota, themselves, seemed to indicate similarly at the results meeting. I suspect we’ll need a little more than just Toyota to help us through 2024.
In the meantime, if it really is just foreign flows that is driving the market, there is little we can do except to maintain our stance. However, we still are actively focusing on some (quality) beta names that we could not ride due to the dislocation between the stock action and fundamentals. If and when they converge, we will be ready.
Masaki Gotoh
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“Repetition of the same thought or physical action develops into a habit which, repeated frequently enough, becomes an automatic reflex.” – Normal Vincent Peale, an American clergyman and author of best-seller “The Power of Positive Thinking”.
My sons joined their school swim team about a year and a half ago. I wouldn’t say they were spectacular swimmers and I’m not quite sure what initially triggered them to go to try-outs. But they both made it in and have practice 4 days a week for 1 to 2 hours each. I personally had no particular interest in swimming. I can get from one end of the pool to the other without sinking (Cornell actually required all incoming freshmen to take a swim test and, if you failed, you were forced to take swimming as your Phys Ed elective, though I never bothered to check why – I got by so took Karate during my first semester and Scuba Diving during the second). But it’s never been one of the sports I’d follow except, perhaps, during the Summer Olympics where the nationalistic side of me would root for Japan.
Of course, now, I’m terribly excited. I subscribed to “Swimming Magazine” which I didn’t even know existed until recently. I’ve bought my sons some training items to help with their stroke and breathing. And my older son, Leo, has upgraded his $20 swim suit to a $100 one – I have no idea what the difference is but the store clerk says he can shave a few milliseconds from his time. More importantly, my son feels more confident in this suit which does look a little cooler than his old one. And I take my sons to the local community pool once every week or two while I watch their well-cut bodies casually swim round-trip across the 50 meter pool. They tell me that they swim anywhere between one to three kilometers per practice so 100 meters is just a simple warmup whereas I can barely make it just one-way before I’m out of breath. So I usually wait in the jacuzzi, along with the other pot-bellied fathers.
As with pretty much every sport you can possibly imagine, there are Japanese comics about swimming with the most popular one being “Rough” which came out in the late 80s. I still have my original copies of the comics (I don’t ever throw away books and even buy new editions of the same one I own). So, of course, I had to scour my tiny jungle of a basement to find them, but it was worth it since Leo has since read the 12-book series probably more than 5x already.
I, too, had to reread it and it was, just as I remember it, one of the best series by this author who is more popularly known for his baseball-themed comics. There is one scene that I particularly like. The protagonist, a first-year high school student named Keisuke Yamato, who never got past third-place in free-style at nationals during his junior high-school years, was ordered by the coach to teach a new student how to properly swim free-style. Because this new student didn’t even know how to swim, he had to start coaching the very basics. Keisuke was a very tough teacher, pushing the new student to his limits to understand just the rudimentary skills. After continuing this training program for months, Keisuke, who had previously chosen to change to breaststroke, had one of his practice free-style runs timed and, to his surprise, he had vastly exceeded his past records (and, of course, quickly chose to go back to free-style and attempt to beat his rivals). It was the constant repetition of working on the basics of basics that got him past the barrier that he couldn’t break through a year before.
We recently hired a new analyst who, unlike the new swimming student, has plenty of experience in picking stocks and investing. However, we wanted to teach him the Greenwald method of analyzing sustainable competitive advantage. And so, like Keisuke, we had him go through hundreds of companies, some in our portfolio or wish list, some that we are contemplating, and some that were entirely random (literally picking a random page in a booklet of stocks). We had him analyze what the sustainable competitive advantage could be via the supply (due to lower production costs or command of resources), demand (3 types of customer captivity), or economies of scale as defined by Professor Greenwald (we have expanded his definition slightly and adjusted them for the intricacies of the Japanese business environment, at least for domestic firms). Additionally, we’d select, during team lunches in the office, a random set of 12 to 16 companies to hypothesize what competitive advantage these companies have (or could have if they did this or that). And this was based on extremely limited information as the sessions were done away from our PCs or cellphones.
These hypotheses should be developed in minutes. Of course, it would take hours to confirm and days to have confidence in them (before we met the company or other industry participants in order to help prove or disprove our hypothesis). But, through habit, we could probably guesstimate if a company fits our definition of quality just by looking at the content of the business portfolio and segmental margins, a list of competitors (or, at least, an industry classification), and a few years of hyper-simplified financials (sales and operating margins for the income statement, current/fixed assets and liabilities and net debt and equity on the balance sheet, and capex, depreciation and change in working capital for the cash flows).
But I’ve rarely gone through so many in such a short period of time. When you have Bloomberg and the web, your mind gets distracted with many of the details that inevitably arise as you decide whether a company is worth researching. I’d probably pull a few past presentations, maybe an analyst report or two (when available), and check recent news. Because the financials available via Bloomberg are so detailed, something odd would pop out. When they did (assuming it wasn’t a Bloomberg input error which still occasionally happen for small caps), I’d end up checking stainless steel prices or euro-yen rates or Chinese foot traffic during that year’s lunar holidays or whatever. But none of that really matters at this stage. Ultimately, the simple items above should suffice to get through the first round of screening to decide “could this company be quality?”. False positives would be dropped during subsequent research steps. False negatives would likely be picked up in future sessions with a fresh pair of eyes after we notice a change in direction such as a sudden rise in margins above peers or a new management team or M&A activity in the industry or perhaps just a newspaper item which we would’ve ignored if we hadn’t worked on these random screens. To screen through 1,200+ investible companies in the universe, all of which are changing a little every year, this skill of quickly assessing the viability of an investment (through the quality lense) is important.
Continuously repeating what once one thought was the obvious is a skill that requires patience and practice but also requires will power to continue doing it properly and methodically. Until very recently, I used to back fill all of my models by hand (and I still do for updates), generally back to 2004 when quarterly figures became available. Even now, the most important details of a company’s basic financials aren’t in the quarterly reports but in their presentations (which, obviously, need to be filled by hand). Furthermore, rarely are they continuous over time. While the process to estimate forward outlook does require experience and judgement, this too is a skill that can be learned through repetition. The methodology to calculate it is exceedingly simple and almost formulaic. And yet, occasionally, I’d reread the bible of valuation, ingeniously named “Valuation” by McKinsey & Co. And when I do, I almost always notice something that I hadn’t in the past (or at least had forgotten). Of course, it’s never something that would fundamentally change the value of our companies, but just a small footnote that gives one a momentary ah-ha moment and provides a second of enlightenment.
Repetition is … well … repetitive. It’s certainly not enlightening. Admittedly, it doesn’t suit my nature. But it IS important and, with the help of Leo’s interest in swimming and our new analyst, I was reminded of just how much.
A reminder to self: Need to buy the most recent 7th edition of Valuation which came out in 2020 … mine is still the 2nd edition from 1995. I’m certain not a lot has changed but I may get to enjoy longer periods of enlightenment!